The positive momentum of the stock market continued in August with the S&P 500 Index up another 3%. That pushed the year-to-date return of the market to 21.5% through the month of August.*

Meanwhile, the bond market, as represented by the Bloomberg Barclays US Aggregate Bond Index, was slightly down (-0.2%) in August as interest rates started to move a little higher.

The market rally paused briefly in the middle of the month as investors worried that the Federal Reserve could cut down on their monetary support. We have also seen lower than expected global economic growth, particularly from China, and the tensions are high in Afghanistan. The stock market dropped about 2% over the course of three days, but quickly rebounded to reach new all-time highs once again.

The S&P 500 has now gone over 200 days without at least a 5% drop. The biggest drawdown this year has been -4.2%. Only three calendar years had drawdowns of less than that: 1995 (-2.5%), 2017 (-2.8%) and 1964 (-3.5%), according to information from Schwab.

This could mean the market is overdue for a pullback. Historically the month of September is the worst month of the year for the stock market, averaging a loss of about 1% since 1928. However, there is no logical explanation for why September has had the worst returns historically. The month has had positive returns the majority of the time when the market is up the first eight months of the year, all according to research from Barron’s.

We still have reasons to remain optimistic about the stock market. Stock analysts continue to revise their company earnings forecasts upward. In 2021, earnings per share for both U.S. and international stocks are estimated to be above those of 2019 prior to the pandemic. For 2022, earnings are forecasted to rise even further and be 20-30% above 2019, according to information from Schwab and FactSet.

The July unemployment report that was released the first week of August provided positive news. Employers added 943,000 jobs in July, which was the best gain in the previous 11 months and the unemployment rate fell from 5.9% to 5.4%, as reported by the Wall Street Journal. This news pushed up bond yields and stock prices.

The Federal Reserve will see one more jobs report before their next meeting on September 21-22. If there is more positive employment news, the Fed might decide to start reducing its bond purchases by the end of the year which have supported low interest rates to help boost the economy.

If this happens, we could see interest rates, including mortgage rates, start to rise gradually, which would create more of a headwind for the economy. However, we believe this action is anticipated by investors so it will not by itself cause a significant drop in the markets.

The Fed has previously announced that it does not expect to raise the federal funds rate (its primary tool for controlling rates) until the end of 2023 at the earliest, which should help keep interest rates low.

The federal debt ceiling will likely start to make headlines again soon. The debt ceiling is a cap on the total amount of debt the U.S. can accumulate which is set by Congress. In 2019, Congress voted to suspend the debt ceiling for two years until July 30 of this year. It is likely that Congress will need to again raise or suspend the debt limit sometime in October, which usually leads to more political drama and some added volatility in the stock market.

We continue to see more positives than negatives for the economy. The U.S. is in the mid-cycle phase of the economic cycle where company earnings and GDP growth rates are near their peak, but will likely continue growing at positive rates for the foreseeable future.

While there are risks such as rising inflation and interest rates, the falling unemployment rate will likely mean that demand for goods and services will remain high. Therefore, we think it is too early in the economic cycle to shift to a more defensive position in our portfolios.

*Morningstar Direct is the source for all return numbers.